First Business Financial Services, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods unless otherwise stated. Dollar amounts are in U.S. dollars. The company operates a commercial bank primarily in Wisconsin and greater Kansas City, with commercial lending, specialty finance, trust and investment services, and business deposit products.
Financial performance
| Metric | Q2 2019 | Six months 2019 | Comparison / context |
|---|---|---|---|
| Net income | $6.6 million | $12.5 million | Up from $3.3 million and $6.9 million, respectively |
| Diluted EPS | $0.75 | $1.43 | Compared with $0.38 and $0.79 |
| Net interest income | $16.9 million | $34.6 million | Down 0.5% for Q2; up 4.4% year to date |
| Non-interest income | $5.8 million | $10.4 million | Up 45.8% and 20.8%, respectively |
| Top-line revenue | $22.7 million | $45.0 million | Up 8.3% and 7.8%, respectively |
| Net interest margin | 3.52% | 3.66% | Down 25 and 5 basis points, respectively |
| Return on average assets / equity | 1.30% / 14.09% | 1.25% / 13.89% | Both measures improved year over year |
| Efficiency ratio | 67.41% | 67.73% | Compared with 67.07% and 67.27%; non-GAAP measure |
Net income benefited from lower loan-loss provisions, higher commercial loan swap fees, and historic tax-credit activity. The provision for loan and lease losses was a benefit of $784,000 in Q2 and $736,000 year to date, versus expenses of $2.6 million and $5.1 million. Compensation expense rose 15.2% in Q2 and 13.6% year to date, contributing to higher operating costs.
Financial position, funding and credit
- Growth: Total assets were $2.070 billion at June 30, up 5.3% from year-end 2018. Gross loans and leases reached $1.721 billion, up $102.3 million; deposits were $1.530 billion, up $74.3 million.
- Cash and liquidity: Cash and cash equivalents were $45.9 million, down from $86.5 million at year-end. Immediate on-balance-sheet liquidity was $359.7 million, versus $390.9 million. Six-month operating cash flow was $11.3 million; investing used $119.0 million and financing provided $67.0 million, resulting in a $40.7 million decrease in cash.
- Debt and funding: FHLB advances and other borrowings totaled $298.0 million; junior subordinated notes were $10.0 million. Wholesale funds were $512.9 million, or 28.4% of total bank funding. The company reported compliance with debt covenants.
- Credit quality: Non-performing assets were $28.5 million, or 1.38% of assets, versus $27.8 million and 1.42% at year-end. Non-accrual loans and leases were $25.9 million. The allowance was $19.8 million, or 1.15% of gross loans, down from 1.26% at year-end. Management cited improved collateral values and lower historical loss rates, partly offset by loan growth.
- Capital and shareholder returns: The Bank remained “well capitalized”; its CET1 ratio was 10.51% and total capital ratio 11.63%. The company declared dividends of $0.15 per share in each quarter and repurchased $3.7 million of stock in the first half.
Material changes, outlook and risks
- Q2 non-interest income growth included commercial loan swap fees of $1.1 million, versus $70,000 a year earlier. Management noted that swap-fee income can vary with client demand and interest rates.
- Historic tax-credit activity was significant: the company recognized $5.3 million in federal historic tax credits and recorded $3.9 million of related investment impairment in the first half. Q2 included $2.4 million of credits and $2.0 million of impairment expense. The six-month income tax benefit was $1.9 million. Management expected a 2019 effective tax rate of 21%–23%, excluding discrete items.
- Management said it expects to maintain net interest margin of 3.50% or better, while noting that loan-fee collections and deposit inflows can create quarterly volatility. The long-term efficiency-ratio goal is 58%–62%; management expects newer producers to support revenue growth and positive operating leverage, but reported ratios remained above that target.
- Management expects loan activity to replace normal amortization and support further growth, while stating it will not relax underwriting standards to pursue growth. CRE represented 66.8% of gross loans, a concentration to monitor.
- Legacy SBA exposures remain a source of credit and expense uncertainty. The SBA recourse reserve was $2.1 million; the company disclosed repurchases of previously impaired sold SBA loans and a $1.5 million net charge to the reserve in the first half. The filing warns that future credit reviews could lead to additional provisions or charge-offs.
- Other stated risks include competition and deposit-pricing pressure, economic weakness and borrower defaults, interest-rate movements, growth-management demands, cybersecurity and fraud, regulatory or accounting changes, and compliance with SBA requirements. Management reported no material change in previously disclosed risk factors and no legal proceedings expected to materially affect the company.
- The company was preparing for the expected-credit-loss accounting standard (CECL); a possible delay was under evaluation. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth, deposit costs and asset yields support management’s stated 3.50% net-interest-margin expectation.
- How recurring earnings perform excluding historic tax credits, associated impairment charges, and variable swap-fee income.
- Whether non-accrual loans, SBA repurchases and recourse-reserve requirements improve or generate further losses.
- Whether expense growth moderates enough to improve the efficiency ratio toward the stated 58%–62% long-term goal.
- How the CRE concentration, liquidity levels, wholesale funding mix and regulatory capital ratios evolve as the balance sheet grows.